This Market Isn’t Ready to Surrender

Although volatility seems higher and the short-term trend is weak, bulls continue to step in to buy the dips. For months, this strategy has proved lucrative.

While we cannot know for sure, the evidence for a correction now is no worse than mixed. Economic data remain solid, allowing the Federal Reserve to go ahead with its expected rate hike next month. And technically, the underlying confidence in the market remains intact.

True, the
CBOE
Volatility Index, or VIX, jumped to a three-month high early Wednesday, but later in the day was well off its highs. This indicator is derived from options prices and supposedly gives us a read on fear. The higher the VIX, the higher the level of implied volatility—and the more fearful investors are.

But compare the current VIX to historical volatility, and the difference is stark. Day-to-day volatility in the Standard & Poor’s 500 index is not much higher than it was in October, when it was so low that the market did not appear to have a pulse. In other words, the VIX seems to be reacting to overnight events, while real buyers and sellers are far more sanguine.

The headlines say that the S&P 500 is down for five days, but chart watchers see something far more encouraging in the data. Out of those declining days, three of them left long lower “tails” on the charts. They sold off sharply to start the day but closed well off the lows, if not near the day’s high price (see Chart 1).

Chart 1

And the chart of the S&P 500 E-mini futures contract shows five of five days during this decline with long lower tails. Traders swooped in to buy the dips and had no problem holding positions overnight.

While not a guarantee that the current weakness will be short-lived, it does suggest confidence by the bulls.

Money flows into exchange-traded funds tracking major indexes also lean bullish. For example, the accumulation/distribution indicator for the SPDR S&P 500 ETF (ticker: SPY), which looks at price movements between the open and close, continues to point higher despite sagging prices (see Chart 2). Even the
iShares Russell 2000 ETF
(IWM), which has been sliding since early October, sports a rising accumulation/distribution.

Chart 2

These proxies for investor sentiment do not pinpoint the end of the current decline. All they can do is suggest that bullish forces still operate behind the scenes, and that does suggest an eventual resumption of the rally.

Aside from stocks, I am a little concerned about the yield curve in the Treasury bond market. The differential between long and short interest rates tightened this month. In an economy that is supposedly improving, we would expect it to expand.

There is still a long way to go before the yield curve suggests serious problems for the economy, but it is curious that it seems to be heading the wrong way.

For the S&P 500, there is still room to fall before it reaches important support from its one-year trendline, which began a few days before the 2016 election. The value at the trendline right now is about 2525, or about 1.7% below Wednesday’s trading near 2570.

We should reserve judgment on whether this is just a dip or the start of something worse until the market gets to that trendline. In the meantime, there is no reason to expect the worst, although it’s probably a good idea to be more conservative with new money until the fog lifts.

Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We’ll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

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